Page 161 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Working Capital Management

Notes
Example: Company A exports goods worth `44, 000, as of today which is equivalent to
$1000 assuming an exchange rate of `44 = 1$. The payment for this export order will be received
after 3 months. During this intervening period if the Indian rupee appreciates in comparison to
dollar by 5% i.e., ` 41.80 = 1$ the effective receipt after 3 months would be `41, 800 only. In order
to avoid this company could take a forward cover through which the unfavourable movement
in currency prices is evened out.
The main function of the treasury department is to maintain liquidity. Liquidity here implies
the ability to pay in cash the obligations that are due. Corporate liquidity has two dimensions
viz., the quantitative and qualitative aspects. The qualitative aspects refer to the ability to meet
all present and potential demands on cash in a manner that minimises costs and maximizes the
value of the firm. The quantitative aspect refers to quantum, structure and utilisation of liquid
assets.

Notes Excess liquidity (idle cash) leads to deterioration in profits and decreases managerial
efficiency.
It may also lead to dysfunctional behaviour among managers such as increased speculation,
unjustified expansion and extension of credit and liberal dividend. On the other hand a tight
liquidity position leads to constraints in business operations leading to, reduced rate of return
and missing on opportunities. Therefore, the most important challenge before the treasury
department is to ensure the ‘proper’ level of cash in a firm.

Self Assessment

State whether the following statements are true or false:

10. There is a direct link between low profits or losses and cash flow problems.
11. The internal factors are those that occur outside of the business and its control.
12. External factors are those that are within the control of our business.

9.8 Summary

 The cash forecast is an estimation of the flows in and out of the firm’s cash account over a
particular period of time, usually a quarter, month, week, or day.
 Long-range forecasts are generally based on accounting projections and typically involved
the generation of various scenarios for future economic and technological environments.
 The purposes of daily forecasting are to assist management in scheduling transfer in cash
concentration, funding disbursement accounts, controlling field deposits, and making
short-term investing and borrowing decisions.
 While sensitivity analysis methodologies give useful information, it is generally the
overall variation from the means of the monthly cash deficits and surpluses that concerns
management for planning purposes.
 This information on the probability distributions of cash surpluses and deficits is necessary
to plan advantageous strategies.
 To estimate these probability distributions, a simulation of the overall uncertainty in the
ending cash balances for cash of the period within the forecast is needed. To get these, the
methods of simulation analysis are used.

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